IDEX Corp. Q2: Project delays, weakness in life sciences (NYSE:IEX)

I highlighted my “Buy” thesis on IDEX (New York Stock Exchange: IEX) in my previous article published in June 2024, arguing for moderation in order growth. IDEX published its Q2 result as of July 31, reporting a 4% drop in organic revenue and the reduction of the full-year growth guidance due to project delays and overall weakness in the industrial market. Despite these near-term headwinds, I am supportive of IDEX's efforts in portfolio management and capital allocation. I reiterate the “Buy” rating with a fair price target of $220 per share.

Acquisition of Mott Corporation

On July 23, 2024, IDEX announced will acquire Mott Corporation for $1 billion, with the deal expected to close in the third quarter of fiscal 2024. Mott is a leader in the design and manufacture of sintered porous material structures and flow control solutions. I am in favor of the transaction for several reasons:

• Mott's solutions have the Potential to expand IDEX’s applied materials science technology. IDEX has been developing its applied materials business over the past several years, and these mission-critical configurable components can contribute to higher gross margin for IDEX over time.
• The purchase price represents a multiple of around 15% based on expected 2025 EBITDA, making it a reasonably priced deal for IDEX in my view. Furthermore, with Mott's EBITDA margin around 20%, the acquisition could potentially improve IDEX's overall margin profile.
• Finally, both companies serve similar customers, so IDEX can leverage its existing sales force to distribute more essential products and solutions. I foresee synergies on both the revenue and cost fronts.

In addition, IDEX divested Alfa Valvole for $45.5 million in cash. Considering that IDEX acquired The acquisition of the company for €102 million in 2015 was not a successful acquisition for IDEX. However, I believe that it makes sense to divest from a low-growth company in order to optimize IDEX's overall portfolio.

Delays and weaknesses in projects in the industrial and life sciences market

During the earnings call, management indicated that there would be some project delays due to the upcoming US elections, as well as some weakness in the overall industrial market. As a result, the company's revenue declined 4% organically in the second quarter, while orders grew 2%.

As noted in my initial report, IDEX has a broad range of end-market exposures and its growth is closely tied to overall industrial activities. ConstructConnect publishes the Project Stress Index on a monthly basis and, as of the latest report In August, overall non-residential construction project delays were relatively high in the first half of 2024, but the stress index fell below the historical average in July. Therefore, I believe that project delays may be a temporary problem for IDEX and business is likely to recover in the second half of the year.

Aside from project delays in the industrial market, IDEX is facing growth challenges in the life sciences and analytical instrumentation markets. As noted in the earnings call, the weakness was due to inventory reduction activities in distribution channels. Management does not anticipate a substantial recovery in this fiscal year. I believe the underlying reason for the weakness in the life sciences and analytical instrumentation markets is the elevated interest rate and tight capital financing environment. As reported by Danaher (DHR) and Thermo Fisher (TMO) during the most recent results, the overall life sciences market was weak in the first half of the year, and both companies anticipate the market will gradually recover in 2025.

Perspectives and DCF

Due to the weakness in the industrial market, the company lowered its full-year guidance for both revenue and earnings per share, as detailed on the slide below.

I calculate the growth for the three main segments as follows:

• Fluid and measurement technologies: IDEX distributes pumps and water solutions, and I expect weakness in the agricultural market, partially offset by some stability in the municipal water market. As mentioned above, project delays have led to weak order growth in its fluid and measurement technologies. Therefore, I forecast a 2% revenue decline for FY24.
• Healthcare & Science Technologies: Due to limited capital funding in the life sciences market, I forecast the life sciences and analytical instrumentation segment to remain weak in fiscal year 2024. Overall, the segment is likely to see slow volume growth in fiscal year 2024 and I forecast total revenue to decline by 5% in fiscal year 2024.
• Diversified and Fire Safety Products: I anticipate stable growth for LSD in the second half of fiscal year 2024, and IDEX will deliver 3% organic revenue growth for fiscal year 2024.

Therefore, I estimate that IDEX’s organic revenue will decline 2% in fiscal 2024. Additionally, I estimate that IDEX’s organic revenue will grow 6.2% beginning in fiscal 2025, assuming: Fluid & Metering Technologies grows 5%; Health & Science Technologies grows 8%; and Fire & Safety/Diversified Products grows 5%, all in line with historical averages.

As I discussed in my previous coverage, IDEX has been actively seeking acquisitions to expand its portfolios. I estimate that the company will allocate 10% of revenue to acquisitions, which will translate into 330 basis points of top-line growth.

I estimate IDEX will generate 30 basis points of margin expansion driven by:

• Gross margin expansion of 15 basis points due to the offering of new products with higher ASPs
• Operating leverage of 8 basis points of SG&A, driven by economies of scale and sales force leverage
• 5 basic points of R&D optimization

The DCF summary is as follows:

WACC is estimated at 8% assuming: risk-free rate 3.8%; beta 0.84; equity risk premium 7%; cost of debt 7%; equity balance $3.5 billion; debt $1.3 billion; tax rate 23%. The fair value of IDEX stock price is estimated at $220 per share.

Key risks

IDEX aims to deliver a price-to-cost spread of 80 to 100 basis points over the business cycle, and in the second quarter it achieved 100 basis points. However, as the inflation rate is returning to its historical levels, I believe it is unlikely that IDEX will reach the highest level of the price-to-cost spread in 2025. Lower price growth could impact IDEX's gross margin.

Final thoughts

Despite near-term challenges stemming from project delays and weakness in the life sciences end market, I am confident in IDEX's long-term growth opportunities. Its active portfolio management allows the company to optimize its products and solutions, while better leveraging its sales force. I reiterate a “Buy” rating with a fair price target of $220 per share.